Emergency Fund - What is it and why do you need one?
At one point or another, you’ve likely heard that old, trusted expression “save for a rainy day”. It’s something that people of all ages should think about when earning money. Essentially it boils down to not being able to predict the future. It’s just not possible. The very nature of life is that you can’t always see what’s around the corner, and every now and then, those ‘rainy days’ do come about.
It’s something that certainly rings true to most South Africans, especially since the beginning of the Covid-19 pandemic. This expression has struck a nerve for most as many were retrenched when the economy came to a screeching halt. Financial emergencies occur for many different reasons and are mostly incredibly unpredictable.
All we’re trying to say is: keep it real.
Don’t think of the ‘rainy day’ scenario as an unlikely one. As the cost of living in South Africa slowly goes up, your ability to cover additional unplanned expenses reduces if you haven’t set aside an emergency fund. Keep it real, start with your very next paycheck and set aside a small portion that is realistic for you. It all helps you avoid getting into debt when that next rainy day shows its face.
How much is enough?
A sufficient emergency fund should ideally contain enough savings to cover at least three times your monthly expenses. Three months is, of course, a starting point, and some individuals opt for at least six months. By saving at least three times your monthly expenses it will help you to self-fund your day-to-day expenses and meet your monthly debt obligations should you lose your ability to earn income in the short term.
While this amount of money might seem like an unrealistic and perhaps daunting target, a good initial target would be to reduce your expenses to 80% of the income you earn on a monthly basis. If you make the effort to save the other 20%, it should take you about a year to build up your emergency fund- and essentially your financial safety net.
The trick with achieving this goal is to save or invest that money (say the 20% of your income) as soon as you receive your salary, or even better – set up a debit order, so that a fixed amount goes into a separate savings account automatically every month. It’s about the discipline and the mindset in not viewing the money you’ve put away as available. In addition, it’s important to realise that every little bit helps – anything you decide to save each month is better than nothing!
A way to start habitual saving habits and be great at working towards financial safety and financial success can be broken down into 3 steps:
Step 1: Understand exactly where your money goes:
To avoid running into any big emergencies or debt, you first need to better understand your current spending habits and where exactly your money goes each month. To do this, start by writing down what you spend your money on every month – even the smallest expenses – and then split it into debt repayments, essential expenses and non-essentials like eating out, take away coffee or subscriptions.
A great way to do this is to print out your previous months’ bank statement and go through it line by line, and figure out exactly what happened. Then from there, decide which of the non-essentials you are spending money on, which is important to you and what you are willing to give up monthly. Once you’ve taken a hard look at your non-essential expenses, you might be able to cut back and start saving the money for a ‘rainy day’ instead.
Step 2: Reassess Your Debt
Few people truly realise how much money they ‘waste’ on debt servicing costs each month. If you’d like to repay your debt first, try to increase the repayment amount and start using debt effectively. This means sticking to good debt, like the bond on your home or your study loan, and using cash for other expenses instead of relying on credit or store cards to pay for those items. You are likely to pay high interest on short-term debt, so make it a priority to reduce it and avoid it where possible going forward.
Step 3: Create a realistic budget!
You’ve assessed your expenses, had a look at where your debt is distributed throughout your monthly expenditures and note that it’s time to create a budget that you will actually abide by. While you need to make allowance for savings every month, you also need to budget for things that you enjoy, otherwise, you run the risk of spending money you don’t have. Give yourself a little bit of "fun money" to look forward to spending and enjoy spending.
If your budget for these non-essential expenses, you can make adjustments to your other monthly expenses to allow for these non-essentials and have fun with the money you are earning. The mistake many of us make is to spend a lot of money on little things, which you may not even be able to recall at the end of the month! Remember, these little things tend to add up… fast. Make the smart choice – budget your money so you can save up for a real treat and not spend small amounts on many things which only provide instant gratification instead of something more substantial!
It’s great to live a thought out and planned financial life, it’s important to balance your leisure and actual essential expenses properly, all whilst saving a little bit on the side! But as we’ve established earlier, it will always be essential to ‘save for a rainy day’.
Fast forward 15 months and say you have an emergency fund: now is the time to review it. Every now and then, you must take a step back and figure out whether or not it still suits you as is and is growing as it should be. It would help if you thought of your emergency fund as a moving target, as your income and expenses are likely to change over time- especially change in the upward direction.
Your emergency fund should be regularly re-evaluated alongside your broader financial plan to ensure that it remains sufficient for your needs should something unexpected happen.
When reviewing the status of your emergency fund, you will need to take factors such as inflation and lifestyle creep into account to accommodate your changing circumstances. In short, make sure your emergency fund can fund your current lifestyle otherwise, you may be left out of pocket in a matter of years.
Do you feel inspired to start the journey to an emergency fund? Think about that peace of mind knowing you can fall back should something go horribly wrong. For other fascinating topics on financial wellness, check out the other blogs available on our website.